Most people know what interest is for something and how it affects the cost of a loan. However, something that is not at all as common is that you have control over what effective interest rate is for something. Here we will take a closer look at what exactly the effective interest rate is and why it is often a really good measure to find a cheap loan.
What is effective interest rate?
In order to get the effective interest rate for a loan, you take and count all the costs associated with the loan. This means setup fees, interest rates, management fees etc. Then all these different costs are calculated together and the cost you then get is then converted to an interest rate per year. Since all costs are included, the effective interest rate will be higher than the ordinary interest rate, provided that there are some extra costs. If the loan has no additional costs besides interest, the effective interest rate will also be at the same level.
The idea of an effective interest rate is to get a figure showing the cost of a loan. Lenders must also present this figure to their customers so that they can quickly find out what the price is.
When looking for a loan it is always a smart idea to compare several different lenders with each other to find the cheapest loan. Here, effective interest rates usually fit very well. For example, we have as often as we can with this in our comparisons on the site.
The only thing to keep in mind is that the loans should be equal in terms of length, size etc. when comparing. If there are two equivalent loans that you compare, effective interest rates are a very good way to see which loan is the cheapest. It is simply that the lender who has the lowest effective interest rate will also be the cheapest to borrow. Then you just have to remember that there can be more aspects than just finding the cheapest loan.
Effective interest rates are, as we wrote, a measure where the cost is calculated on an annual basis. This makes it ideal for loans of 1 year or more. Mortgages, car loans, private loans, etc. are loans of this type and then effective interest rates work without any problems.
Micro loans and effective interest rates
However, what one should watch out for is micro loans and effective interest rates. A 30-day loan is not really good when you convert it into an effective interest rate. This then the way of calculating then means that one would borrow money for a full year to pay off the first debt, which is obviously not realistic. Therefore, you get an effective interest rate that can be several thousand percent. For micro loans, it is therefore usually better to ignore the effective interest rate and instead concentrate on the actual cost in kronor. Compare this and you will get a more easy-to-understand answer.
At the same time, it should be said that it is actually possible to use effective interest rates even for micro loans, but then the condition is that two identical loans are compared. For example, it will make a big difference if it is 30 or 60 days. But two loans at the same amount and for the same time can be compared with effective interest rates. Although the interest rate that comes up is not easy to get a grip on, you know that it is the least expensive of the two.